If you want to report the dividends you earned and reinvested during the year, Schedule D is not the right piece of paper. You must move to an earlier point in the alphabet and use Schedule B to report reinvested dividends. Dividends are reported on Schedule D after you sell the underlying shares.
Reporting Earned Dividends
Dividends you earn from stock or fund shares will be taxable income for the year the distributions are paid. It does not matter whether you take the dividends in cash or reinvest them to buy more shares. The fund company or dividend reinvestment plan sponsor will send you a Form 1099-DIV at the end of the year and you can transfer the dividend totals directly to your Form 1040 or Form 1040A. If you earn more than $1,500 in dividends and interest, you must also complete a Schedule B to list the investments that paid you all of those earnings.
Reinvestment and Cost Basis
The value of your reinvested dividends increases your cost basis in the stock or fund investment. Basis becomes important when you sell shares, because you must pay capital gains tax on the difference between the selling price and the cost basis. You can think of this difference as profits. Schedule D is used to report gains or losses on investments, so Schedule D is relevant to reinvested dividends only when you are calculating your gain or loss from the sale of shares that produced the dividends.
Cost Basis Acccounting
The tax rules give you a choice of three methods to determine cost basis with reinvested dividends. The average cost method takes all of your investments, including reinvested dividends, and divides the total by the number of shares you own. Basis will be the average cost per share. First-in-first-out cost accounting assumes any shares you sold were the first shares purchased equal to the number of share sold. Purchases in this case include shares acquired through reinvestment. The specifically identified method is self-explanatory. You identify the shares you sold by purchase date and cost. These can be shares you bought or those picked up through reinvestment of dividends.
Selling Investment Shares
When you sell shares of your stock or fund, the results are reported on Form 8949 and Schedule D. You list the shares sold using your selected cost basis method on Form 8949 and transfer the totals of your investment gains and losses to Schedule D. Final profit or loss results end up on your tax return. The broker, sponsor or fund company must provide cost basis information to you and the Internal Revenue Service. It is important coordinate with the company holding your shares to make sure you are on the same page for basis reporting.
Tim Plaehn has been writing financial, investment and trading articles and blogs since 2007. His work has appeared online at Seeking Alpha, Marketwatch.com and various other websites. Plaehn has a bachelor's degree in mathematics from the U.S. Air Force Academy.